New tax rules may result in final distribution of funds on closure of a company being taxed as dividends instead of capital gains.
A capital gain is usually preferable to dividend treatment. This is because capital gains are generally taxed at a lower rate than income, possibly as low as 10% where entrepreneurs relief is available.
For example, a higher rate taxpaying shareholder receiving £100,000 on the liquidation of his company would pay £32,500 (32.5%) if taxed as a dividend, whereas CGT would be just £10,000 (10%) if entrepreneurs relief is available. .
When is a liquidation taxed as income?
For the new anti-avoidance rules to apply, the company being wound up must firstly be a close company and the individual must have held at least a 5% interest in the company (ordinary share capital and voting rights).
A further condition is that the individual (or connected person) continues to carry on the same or a similar trade or activity to that carried on by the wound-up company within the two years following the distribution.
It must also be reasonable to assume, having regard to all of the circumstances that the arrangements appear to have a tax advantage as one of the main purposes.
Can we obtain clearance prior to the liquidation?
Accountants and tax advisors requested that the new anti-avoidance rules should provide a formal clearance procedure prior to the transaction, thus providing certainty as to whether or not the payment would be taxed as income or capital. Unfortunately, there is no formal clearance procedure. HMRC have however received a number of clearance requests from taxpayers and have confirmed that it is not their general practice to offer clearances on recently introduced legislation with a purpose test.
HMRC have therefore drafted a standard reply that sets out a small number of examples and they are working on more detailed guidance, which should be published before the end of this year.
This is a very complex area and we suggest that you contact us before you consider closing your company if you have significant funds in the company. It may be that other alternatives should be considered including pension payments prior to cessation of the company’s trade, or maintaining the company and paying dividends out of it over a longer period.